India’s corporate governance cleanup is welcome

India’s corporate culture is about to witness a shakeup. A new law will make it mandatory for most Indian companies to separate the role of the chief executive and the chairman of the board. The shift, already the norm in the United Kingdom but long resisted elsewhere, should help to narrow India’s governance discount.

The change is far from cosmetic. The CEOs of about half of India’s top 50 listed companies double up as chairmen. Those that want to continue combining the roles will need the explicit approval of their shareholders.

The country’s securities regulator is also getting in on the act. The Securities and Exchange Board’s proposed governance norms for publicly traded companies are actually tougher than corporations face in more advanced economies. For instance, India may require independent directors resigning their position to publicly disclose the reason for their departure – and “personal reasons” won’t be considered a satisfactory answer if directors are only giving up one of multiple directorships.

The regulator also wants to explore the viability of requiring companies above a certain size to appoint at least one independent director from among small shareholders. The idea is worth a try. Company founders in India encounter little or no opposition from eager-to-please boards. A particularly egregious instance was the way independent directors of Satyam Computers rubber-stamped the former CEO’s desperate attempt to cover up fraud in December 2008.

Of course, changing the rules is no guarantee of future good behaviour. Even boards that boast of independent leadership can do better. Infosys Technologies, the only Indian entry last year in CLSA’s selection of 20 large Asian companies with best corporate governance, lists KV Kamath, a former banker, as a non-executive chairman. But a former Infosys CEO holds the position of executive co-chairman. Meanwhile, Kamath continues to be “independent” chairman at ICICI Bank, even though he was its founding CEO.

In Asia’s corporate governance rankings, India lags behind Singapore, Hong Kong, Taiwan, Malaysia and Thailand, but ahead of China, South Korea, the Philippines and Indonesia, according to CLSA. Moving up the ladder should make the market more attractive to overseas investors.

Left to their own devices, companies would be reluctant to change, as they have been in the United States. And while an overly legalistic approach can backfire, using regulation to give companies a nudge forward is a sound idea.

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The Securities and Exchange Board of India, the country’s market regulator, unveiled a set of proposals on Jan. 4 seeking to boost corporate governance standards for publicly traded companies.

The proposed measures include separating the roles of the chief executive and the chairman of the board. The regulator’s move follows in the path of the new Companies Bill, which was recently passed by the lower house of parliament.

Once the bill becomes law, most companies that continue to vest both responsibilities in one person will need to amend their constitutions with shareholders’ approval.